4/02/2001 @ 12:01AM

Street Fight: WorldCom

WorldCom
joined the growing list of companies cutting their payrolls when it laid off roughly 7% of its workforce at the end of February. Since a December low, WorldCom shares have risen 41%. Will the company succeed in its turnaround efforts, and is the stock still a buy after its recent runup?

Kevin Calabrese: First of all, WorldCom is not going out of business, and their assets are undervalued right now. They’re going to split up the company and issue two tracking stocks: one for MCI and long distance, and the other for WorldCom’s data services operations. UUNET [a WorldCom company], which is the biggest piece of the Internet backbone in the world, is going to be phased into WorldCom’s own services, rather than have its own brand name. Growth of the Internet is still phenomenal and the necessity of businesses to use the Internet and direct data operations is simply going to grow over the next few years.

WorldCom is still profitable. If you look at the value of the dividend they expect to pay, I think that $10 is a very reasonable valuation for the MCI tracking stock. On the remainder of the WorldCom businesses, I’m looking for a price-to-earnings multiple of 21 expected on the growth rate of the WorldCom businesses, and I’m expecting a price of about $26. Combined, it gives you a current valuation in the marketplace that’s too low by almost half.

Dan McBride, you’re staying with a “neutral” rating on the stock. Your response?

Dan McBride: Its growth is going to be relatively slight, and earnings are expected to go down. With MCI, I think a $10 valuation is quite a leap, and I wouldn’t go as high as $26 on the data services business either. I might be inclined to say something more like $20 to $21. I think the stock price should be a tad higher than it is now, but not enough for us to take it out of the neutral classification.

Because of the market uncertainty and the possibility of further decline, I think the pricing pressure that’ll be exerted from the number of new companies and new networks coming online will be enough to keep earnings growth down in the single-digit area. As a result I wouldn’t look for WorldCom’s share prices to go up by that much.

Kevin Calabrese, your thoughts on WorldCom’s competition?

Calabrese: Yes, there are a lot of small companies out there desperately trying to stay in business, offering extreme discounts, and causing price competition right now. However, most of those companies will be out of business or will have to sell their assets very shortly. WorldCom will be around to pick up that business.

The smaller companies also can’t compete on price, because price is really a secondary factor compared to service. Quality of service and longevity are two other advantages that WorldCom offers.

It is a difficult time in telecom right now and there is some cloudiness as to the future, but I do think with a company like WorldCom, you can buy very good assets and wait for the economy and the markets to make them as valuable as they should be.

The last word goes to Dan McBride:

McBride: The belief surrounding the smaller competitors dying off quickly is widespread, but I don’t think it’s going to happen all that soon. Some will go out of business, but others will continue to do well and gain market share. I’m not sure WorldCom will regain a footing in an industry filled with so much turmoil.

In fact, the industry has become so difficult and challenging that even the best players are now under a lot of pressure just to maintain relatively modest earnings growth. There are going to be more players than there used to be, and I think WorldCom’s share will come down as a result. Given the risk and the lack of visibility surrounding earnings growth, I expect WorldCom to trade at a slight discount to the S&P 500 as opposed to a premium.

WorldCom Financials
Prices as of March 29. * Annualized; projected over the next three to five years. Sources: Bloomberg Financial Markets; FT Interactive Data and Thomson Financial/IBES via FactSet Research Systems